Monthly Market Update – July 2023

Key Points

• 1st Half Rally Carries into 2nd Half Though the stock rally slowed from June’s strong pace, the positive momentum persisted through July, with the S&P 500 climbing +3.1% for the month. That follows June’s +6.5% return, the best month since October 2022. It also adds to the +16.9% for the first half of 2023, the second-best start to a year in the last 25 years. Six of the seven months of 2023 have been positive.
• The Haves and the Have Nots As impressive as overall stock performance has been in 2023, most of the gains came from just seven companies. The S&P 500 Index is up more than +20% this year, but the so-called “Magnificent Seven”—Tesla, Apple, Nvidia, Microsoft, Amazon, Meta, and Alphabet—have soared more than +65%. The remaining 493 stocks in the index are up less than +8%.
• Spread the Wealth Fortunately, the narrowness of the market leadership continued to expand in July. In the first five months of the year (i.e., through May 31), the S&P 500, which is essentially the largest 500 U.S. stocks, was up +9.7%, while the Russell 2000, which is the smallest 2000 U.S. stocks, was flat for the year with a -0.04% return. But the Russell 2000 outperformed the S&P 500 in June and July by nearly +5%.
• Consumer Attitudes Improving, Finances Worsening With the tight labor markets, inflation well below last year’s peak levels, and virtually all capital markets enjoying healthy year-to-date gains, it shouldn’t be surprising that consumers’ moods have improved. Indeed, measures such as Consumer Confidence and Consumer Sentiment are at their highest levels of the year. However, they may be challenged going forward as Consumer Credit deteriorates. Credit card balances just topped $1 Trillion for the first time, the average interest rate on credit card debt just hit a record 25%, and credit card delinquencies hit an 11-year high.
• Overseas Macro Malaise We’ve chronicled the slowdown in China for months, and that course has continued unabated. China’s CPI (consumer inflation) just turned negative for the first time in 29 months—prior periods of deflation by the world’s second-largest economy only happened around global slowdowns. Meanwhile, Chinese exports plunged -14.5% in July, imports were down -12.4%, and net foreign direct investment in China is the lowest since data began in 1998.

Market Summary

Asset Class Total Returns

Source: Bloomberg, as of July 31, 2023. Performance figures are index total returns: US Bonds (Barclays US Aggregate Bond TR), US High Yield (Barclays US HY 2% Issuer-Capped TR), International Bonds (Barclays Global Aggregate ex USD TR), Large Caps (S&P 500 TR), Small Caps (Russell 2000 TR), Developed Markets (MSCI EAFE NR USD), Emerging Markets (MSCI EM NR USD), Real Estate (FTSE NAREIT All Equity REITS TR).

After a stellar +16.9% return for the S&P 500 Index in the first half of 2023, the second-best start to a year in the last 25 years, investors remained ebullient in the first month of the year’s second half. Though the stock rally slowed from June’s torrid pace (+6.5%, the best month since October 2022), the positive vibes persisted in July, with the S&P 500 climbing another +3.1%. Besides February, the S&P 500 has been positive for every month of the year. The gains came despite the Federal Reserve raising the fed funds rate to 5%–5.25%, its highest level in over two decades, signaling it will remain hawkish until inflation falls to and stays near its 2% target. There is no Fed policy meeting in August, so the next rate decision won’t come until the September 19-20 meeting. July brought good news on the inflation front as the June Consumer Price Index (CPI) report, released mid-month, showed inflation fell to +3.0% year-over-year, far below the 9% peak from June 2022. Second-quarter Gross Domestic Product (GDP) was also released in the month’s final week. It showed a better-than-expected +2.4% growth rate for the U.S. economy (quarter-on-quarter annualized), which provided another boost for equities.

It is worth noting that the stock rally hasn’t been very robust below the surface. For much of 2023, just two sectors drove most U.S. stocks’ gains. Through July, the Technology and Communication Services S&P 500 sectors were up more than +45% each. The Consumer Discretionary sector also had a strong showing, up +35%. Performance was even more concentrated than that, with just seven stocks responsible for most of that performance. We discuss that in further detail below, but keeping it at the sector level for now, the next best sector, Industrials, was up ‘just’ +12%. This means 8 of the 11 S&P sectors have year-to-date (YTD) returns substantially below the S&P 500’s overall +20.6% return. Fortunately, July brought some broadening out of returns, with Energy as the best-performing sector, advancing +7.3%. Communication Services was still the second-best sector, up +6.7% for the month, but Financials and Materials came in the third and fourth spots with returns above the S&P 500’s +3.2% July return. Technology and Consumer Discretionary fell to the middle of the pack, albeit with respectable one-month returns in the +2.5% range.

Although not quite as strong as the U.S., international stocks also performed well in July and enjoyed double-digit YTD gains. Developed Market international stocks (MSCI EAFE Index) were up +3.2 and +15.3 for July and YTD, respectively. Meanwhile, Emerging Market stocks jumped +6.2% in July and are up +11.4% YTD.

Returns weren’t nearly as rosy in the world of fixed income, as bond prices primarily declined in July and yields mostly edged higher. The benchmark 10-year Treasury yield ended July at 3.96%, up +12 basis points from 3.84% at the end of June. U.S. Bond indices were little changed in July, with the Bloomberg Aggregate U.S. Bond Index dipping -0.1%, while International Bonds (Bloomberg Aggregate Global Bond Index ex U.S.) were up +1.3%. And both bond indices are up about +2% for the year.

It is nice to have such a solid start to the year to remove the sour taste of 2022, but challenges remain. Investors may be tested in the back half of the year. Seasonality tends to be a hurdle in August and September, historically two of the worst-performing months. On the first day of August, the credit rating agency Fitch downgraded the U.S. Government to AA+ from top-rated AAA. The downgrade applies to U.S. Treasuries and the debt of the U.S. Federal Agencies (GNMA, FNMA, FHLMC). Fitch cited the following reasons for the downgrade: the expected fiscal deterioration over the next three years, a high and growing government debt burden, and an erosion of fiscal governance. The Fitch rating change reflects a weakening credit view. Still, it is unlikely to have a material adverse impact in the long term as U.S. Government securities remain the world’s largest and most liquid bond market. Markets are more likely to face pressure from overseas as China and the Eurozone struggle with material economic slowdowns. In just the first week of August, China reported that exports plunged -14.5% in July, imports were down -12.4%, and net foreign direct investment in China came in at the lowest level since data began in 1998. And for the first time in 29 months, China faces deflation as its CPI turned negative, something that has only happened in the past during global recessions. As for Europe, the European Central Bank (ECB) also raised rates in July while the eurozone composite Purchasing Managers’ Index (PMI) fell to 48.6 – levels below 50 suggest economic contraction. The eurozone manufacturing PMI fell to 42.7, marking its lowest level in three years, and has been in contraction for an entire year.

The U.S. economy remains resilient, buoyed by a strong labor market and hardy consumer spending. The risk of recession has receded for 2023, and more-and-more market strategists are calling for a soft landing. If the Fed is nearing the end of their rate hiking campaign, the corporate earnings contraction troughs, and credit conditions don’t tighten much further, then a brief and shallow downturn may be the worst scenario, with the beginning of a new business cycle possibly taking hold in 2024.

Source: Bloomberg, as of July 31, 2023.
Price Returns for Equity, Total Returns for Bonds.
* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.

Quick Takes

THE ‘MAGNIFICENT 7’ HAD 7 MAGNIFICENT MONTHS

As impressive as the overall stock performance has been in 2023, the bulk of the gains were coming from just seven companies. The S&P 500 Index is up more than +20% this year, but the so-called “Magnificent Seven”—Tesla, Apple, Nvidia, Microsoft, Amazon, Meta, and Alphabet—have soared more than +65%. The remaining 493 stocks in the index are up less than +8%. That means those seven stocks account for $4.5 trillion (or nearly 70%) of the S&P 500’s $6.5 trillion market growth this year. Historically the market has struggled to sustain gains with such extremely narrow leadership. Fortunately, July brought evidence of market gains broadening out. The chart below shows that almost all the +7.3% 2023 return for the “Other 493 Stocks” came in July. As mentioned above, new sectors also began to lead in July, notably Energy, Financials, and Materials. Moreover, the small-cap Russell 2000 Index outperformed the large-cap S&P 500 Index in June and July.

S&P 500 Year-to-Date Gains

Market Value Weighted Average Return (%), 12/30/2022 to 7/28/2023

Source: Bloomberg, Horizon Investments.

GLOBAL EARNINGS DECELERATION SHOWS SIGNS OF BOTTOMING

Global earnings growth, which has been decelerating since 2021, showed signs of stabilizing during Q2. Emerging markets remained laggards, with a double-digit earnings contraction on a year-over-year basis. Global earnings growth expectations for the next 12 months remain similar across the world in the low single digits. In the U.S., Wall Street analysts project that S&P 500 companies will see the most significant contraction in earnings growth in the almost-complete second-quarter earnings season. With more than 90% of S&P 500 companies reported, second-quarter earnings growth sits at -8.25%, and currently are forecast to return to positive growth in the third quarter at +0.2% EPS growth.

Global Earnings Deceleration Shows Signs of Bottoming

DM: Developed markets. EM: Emerging markets. EPS: Earnings per share. Forward EPS: Next 12 months’ expectations.
Indices: DM = MSCI EAFE Index; EM = MSCI Emerging Markets Index; U.S. = S&P 500.
Source: MSCI, Bloomberg, Fidelity Investments. Data as of 6/30/23.

CONSUMER ATTITUDES ARE IMPROVING

U.S. consumers are feeling more confident than they have in two years. The Conference Board’s Consumer Confidence Index jumped to 117.0 in July, easily beating economists’ expectations for 112 and far off the lows of 95.3 last July. Consumer confidence tends to signal whether the economy is improving or worsening, with readings below 80.0 as the level associated with a recession within the following year. Meanwhile, the final July University of Michigan Consumer Sentiment Index report was 71.6, the highest reading since October 2021. A year ago, the index was at 51.5. Both measures show consumers in a much-improved state and do not indicate recessionary conditions.

Consumer Confidence and Sentiment are Much Improved

Source: The Conference Board, University of Michigan, Bloomberg.

CONSUMER FINANCES ARE FACING STRAINS

Although consumer confidence and sentiment are at their best levels in years, there are indications they may be challenged going forward. Americans borrowed more than ever on their credit cards in the last quarter as balances surpassed $1 trillion for the first time ever. Meanwhile, the average interest rate on credit card debt just hit a record high of 25%. As shown in the chart below, credit card balances have risen sharply. Total credit card debt jumped by $45 billion in the last three months and is up nearly $250 billion since 2021. The average American credit card balance is at a record $7,300. America went from receiving unprecedented levels of fiscal and monetary stimulus to borrowing record levels of debt in just a few years. New York Fed economists aren’t alarmed about the trend, though, noting in a blog post accompanying the data release, “Despite the many headwinds American consumers have faced over the last year — higher interest rates, post-pandemic inflationary pressures, and the recent banking failures — there is little evidence of widespread financial distress for consumers.”

U.S. Credit Card Debt Balances

Source: Federal Reserve Bank of New York, Reuters.

DELINQUENCIES ON CONSUMER DEBT RETURNS TO PRE-COVID LEVELS

Record levels of consumer credit card debt at record cost to service that debt naturally doesn’t make for a great combination, and that may be beginning to show. Delinquency on getting those debts paid is back to pre-Covid levels, and total household debt has risen to a record $17 trillion, according to the New York Fed. Credit card delinquencies reached an 11-year high. Auto and home loan delinquencies have also increased, though not as sharply as credit card delinquencies.

New Delinquent Balances by Loan Type

Source: New York Fed Consumer Credit panel/Equifax
Note: 4 Quarter Moving Sum
Note: 30 or more days delinquent. Student loans remain in a pandemic induced forbearance period. Student loan data are not reported prior to 2004 due to uneven reporting. Home equity loans with a revolving line of credit are loans, secured by the property, where the borrower can choose when and how often to borrow up to an updated credit limit.

DON’T FORGET THE OTHER SIDE OF THE EQUATION

They call it a balance sheet for a reason, and when the headlines are blaring about the debt side of the balance sheet, it’s easy to forget about the asset side. Perhaps one of the reasons the Fed’s interest-rate hiking campaign hasn’t reined in consumer spending despite the rising credit balances and debt costs is because household net worth has also rebounded – to near-record levels. Households’ net worth returned to near-record heights of $141 trillion in the first quarter. The easing monetary policy during COVID allowed many Americans to reduce their debt burden and refinance or take out low-rate loans. Over 70% of household debt comprises mortgage balances, which were essentially unchanged last quarter at $12 trillion. Additionally, wages are rising, and people are still benefiting from Covid-19 stimulus money (although those excess savings are on pace to be depleted by the end of the year). Moreover, as already discussed, virtually all asset classes have appreciated nicely in 2023, and interest-bearing accounts and securities are paying generous yields not seen in years, helping to offset rising interest costs.

U.S. Households Net Worth

Source: Federal Reserve via St. Louis Fed, The Wall Street Journal.

Asset Class Performance

The Importance of Diversification. Diversification mitigates the risk of relying on any single investment. It offers many long-term benefits, such as lowering portfolio volatility, improving risk-adjusted returns, and helping investments to compound more effectively.

Source: Bloomberg.
Asset‐class performance is presented by using market returns from an exchange‐traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange-traded funds recommended by The Retirement Planning Group. The performance of those funds may be substantially different than the performance of the broad asset classes and to proxy ETFs represented here. US Bonds (iShares Core US Aggregate Bond ETF); High‐Yield Bond (iShares iBoxx $ High Yield Corporate Bond ETF); Intl Bonds (SPDR® Bloomberg Barclays International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 Value ETF); Mid Growth (iShares Russell Mid-Cap Growth ETF); Mid Value (iShares Russell Mid-Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares MSCI EAFE ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares US Real Estate ETF). The return displayed as “Allocation” is a weighted average of the ETF proxies shown as represented by: 30% US Bonds, 5% International Bonds, 5% High Yield Bonds, 10% Large Growth, 10% Large Value, 4% Mid Growth, 4% Mid Value, 2% Small Growth, 2% Small Value, 18% International Stock, 7% Emerging Markets, 3% Real Estate.

* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.

Chris Bouffard is CIO of The Retirement Planning Group (TRPG), a Registered Investment Adviser. He has oversight of investments for the advisory services offered through TRPG.

Disclaimer: Information provided is for educational purposes only and does not constitute investment, legal or tax advice. All examples are hypothetical and for illustrative purposes only. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed. Please contact TRPG for more complete information based on your personal circumstances and to obtain personal individual investment advice.